The present invention relates generally to assessing a finance company's equity adequacy and, more particularly, to a risk-based method for assessing an automotive finance company's equity adequacy.
Finance companies need to provide creditors with high confidence of repayment. Conventionally, financing companies assess their capitalization merely in terms of equity and existing debt. What the conventional analysis lacks, however, is the reliable assessment of alternate sources of creditor protection. For example, deferred taxes in the event of an overall loss can be included as equity for creditor protection. Similarly, future tax liability and future income are alternate sources of creditor protection not included in the conventional equity assessment.
Another shortfall of the conventional capitalization assessment is the absence of an unexpected loss assessment at the 99.9% confidence level for each of the finance company's categories of risk.
Furthermore, the conventional assessment fails to correlate occurrences of unexpected loss by falsely assuming that all unexpected losses occur at the same time. As a result, the conventional assessment quantifies potential uses of creditor protection at a level higher than realistically necessary.
What is needed is a risk-based method for assessing equity adequacy that integrates conventional and alternate sources of creditor protection, a risk-based assessment of unexpected loss at the 99.9% confidence level and a practical correlation between occurrences of unexpected losses.